Unveiling the truth behind EMI – should you avail it or avoid it?

“There no free lunches in this world”, the line goes perfectly when we talk about equated monthly installments or EMI. It is heard and believed that EMI saves one from a pocket cut at an initial point of time of incurring an expense. Thus, help to defer the expenditure r-epayment over a period of time.

But is the math really that simple behind EMIs or is it actually so? No, a lot of hidden add-on charges and costs including the interest is added into the Installment amount. This is not prima facie understandable/visible to the user or beneficiary of the EMIs but in fact, these are right there.

This blog is divided into the following three key parts:

What is Equated Monthly Installment or EMI? Understanding EMI with an example.

Advantages of the EMI payment system

Disadvantages of the EMI payment system

Let’s get into the blog to understand further:

What is Equated Monthly Installment or EMI?

Equated monthly installments (or EMIs) as the name suggests are basically repayment of principal along with interest in installments over a period of time for the expenses made today instead of a lump sum one-time payment on the same day.

Furthermore, if you go by what the dictionary says, An EMI is a fixed payment made by the borrower to a lender at a pre-specified date each calendar month to pay-off both the principal and the interest components.

Understanding EMI with an example

Let’s understand us to take an example. The EMIs are based on the following parameters:

Principal amount

Interest amount

Period

Processing charges(if any)

So let us assume that a person, say, for example, Anuj Purchased plans to purchase a mobile phone worth INR 50,000 today. He comes into an EMI arrangement for a period of 6 months in which he will be making a down payment of INR 10,000 and repayment of balance amount in 6 equated monthly installments or EMIs of INR 7500 each.

Actual cost of Phone (less) the down payment =50,000 (-) 10,000 = 40,000 which is the balance amount.

Anuj has to pay the remaining amount of INR 40,000. But what he is actually paying is =7,500*6 or INR 45,000. Here, Anuj has to bear an extra cost burden of INR 5,000 as interest and other charges for the credit period given to him of 6 months.

Isn’t this taking a toll on Anuj’s pockets?

Yes, it is, then there are also companies coming up with zero interest EMI. But, would you actually believe in something like a zero interest EMI? Let’s unfold the science behind these.

Zero interest EMI – are they?

Like I mentioned there are no free lunches in this world, there is actually nothing free to give away in the world that we are in. Here is what the actual Scenario is, when credit companies offer Zero Interest EMI, then at that time they are not transferring the discounts availed by them from the manufacturers leading you to pay an extra cost which is the ‘hidden cost’ and thus falsely making you believe you pay nothing additional or more.

Then there are companies who would be charging processing fees and other charges at a rate as high as 1-2 % over the transaction value which is basically their service charges for these namesakes NO interest EMIs.

Therefore, before you consider deciding whether to enter into an EMI based transaction or not, consider the following:

Advantages of the EMI payment system

The following three are the advantages of EMI’s.

1. Flexibility

For sure, EMIs allow flexibility to the consumer regarding the duration over which the Principal has to be repaid along with the amount of down payment. This added ease of payment at the customers end.

2. Affordability

EMIs allow one to not take a full load of an expense today and allow them to spread the burden over the period resulting in increased purchasing power today. Off course with extra burden over the actual cost which again spreads over the period you choose.

3. Future outflow

The basic benefit of EMI to make the payment in future basically saves the hole in the pocket today since you have to make payments over a specified or pre-decided period of time and this also helps generate the possibility of earning a certain amount of interest from the money you have saved today.

Disadvantages of the EMI payment system

1. Early repayment comes with big charges

If there are funds available to you, then you cannot make premature payment of principal as this attracts pre-closure charges which are pretty high in most cases and thus increasing the cost by many folds.

2. Increased debt burden

Since EMIs increase the purchasing power. One tends to make an unnecessary expenditure or more expenditure than what they are earning. They think about repaying in future which leads to the increased debt burden.

3. Penalty charges

In case you fail to make or repay any installment as per the agreed timeline, the total outstanding amount attracts huge penalties which ranges about 24-36% which is pretty high if we consider the cost of the asset acquired.

4. Processing charges

Last but not the least, many credit companies charge the processing fee for the EMI payment facilities ranging between 1-2 %.

5. Lesser discounts

You might have noticed heavy advertisements for Zero Interest EMIs especially during the festive season, these are offered for various products but lesser or no discounts are offered on them. Basically, this hidden cost is charged or covered by the Credit companies.

6. Obsoletion of the product

Talking specifically about technology here, which is one thing that gets obsolete pretty quickly, so imagine you taking credit for a phone and within a few months technology upgrades and then you are paying for something which is obsolete in the market.

Therefore, one should consider the above advantages and disadvantages before reaching out to any conclusion.

Purchasing car on EMI – is it worth?

Let’s take one more example here and this time with a car loan:

You want to purchase a car with a loan of INR 5,00,000. The tenure is 3 years at 8% rate of interest or a pre-computed IRR (the rate at which the present value of inflow and outflow is zero) or XIRR, to note here the basic difference between an IRR or an XIRR formula in excel is the period while in case of IRR, the period is fixed between two cash flows, in case of XIRR, the period can vary and not be equal like a day or 2 days or 15 days.

Coming back to our car loan example, the monthly EMI would be around INR 15,668 which totals to INR 5,64,055 over a period of 3 years and here you end up paying an excess of 64,055 as interest for a car worth INR 5,00,000.

Is it the right decision to made? Maybe yes, maybe not. Depending on how you weigh the pros and the consequences. Enquire well into your buying power, your opportunity costs with the money you are spending and your pockets, before you decide.

What’s more is we have experts with us. Experts waiting to assist you in finding a resolution to your EMI or no EMI dilemma. Start right away and get the best advice for your financial needs and plans. Just click here for the best loan advisors near you!

If you still have any questions and would like some professional help? Let our experts do the thing for you. Just post your questions in the comment box below. Our Expert Advisorsshall reach out to you with the right answers soon!

About Author

Priyanka Gaur is a blogger & creative writer with a specialty in Financial Products & Services. An avid reader & a financial analyst herself, Priyanka covers almost entire personal finance space with equal expertise & depth. Priyanka analyses and writes the articles in such a simple way that she makes even the most complicated financial subjects look easy & fun to understand. Besides blogging & writing, Priyanka also manages the product at Money Dial.